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by Rakesh Waghela

2.5 DLG and FLDG

Rule summary

Section titled “Rule summary”

A Default Loss Guarantee (DLG) — also commonly called First Loss Default Guarantee (FLDG) — is a contractual arrangement under which an LSP (or another party in a digital lending arrangement) promises to compensate an RE for losses on a defined loan portfolio, capped at a defined percentage of the portfolio.

For years, FLDGs operated in a regulatory grey zone — some had aggressive structures (20%+, sometimes 100%) that effectively transferred credit risk from the RE to an unregulated LSP. In June 2023, RBI formalised the framework with strict caps.

Source citation

Section titled “Source citation”
  • RBI Guidelines on Default Loss Guarantee in Digital Lending, DOR.CRE.REC.21/21.07.001/2023-24, dated 8 June 2023. Available at rbi.org.in.
  • RBI FAQs on DLG in Digital Lending (issued shortly after).

The 5% cap

Section titled “The 5% cap”
  • A DLG arrangement cannot exceed 5% of the loan portfolio (the portfolio being the loans covered by the specific DLG agreement).
  • The cap is computed as (DLG amount) / (outstanding portfolio at time of computation).
  • The cap is hard. There is no exception for “tail-risk” or “asymmetric” structures.

Permitted DLG providers

Section titled “Permitted DLG providers”
  • LSPs as defined in the Digital Lending Guidelines.
  • Other entities permitted to provide DLG under the framework (the circular details the permitted set).

A DLG can only be provided by an entity authorised under the framework — not arbitrary third parties.

Permitted forms of DLG

Section titled “Permitted forms of DLG”

The DLG can be in one of three forms:

  1. Cash deposited with the RE.
  2. Fixed deposit maintained with a scheduled commercial bank, with lien marked in favour of the RE.
  3. Bank guarantee in favour of the RE.

No other instrument qualifies. Crucially, a corporate guarantee from the LSP itself is not a permissible DLG instrument — the regulator wants assets, not promises.

Accounting and disclosure

Section titled “Accounting and disclosure”
  • The RE must not treat the DLG as substitute for credit risk weighing — the RE continues to compute provisioning, asset classification, and capital adequacy based on its own credit assessment.
  • The DLG is invoked after the underlying loan turns NPA, not before.
  • The RE must publicly disclose the total DLG cover received and the breakup by LSP annually.
  • The DLG amount sits as a contingent asset on the RE’s books until invoked.

Time limits

Section titled “Time limits”
  • DLG can be invoked within 120 days of the loan turning NPA (broadly — the exact timeline is defined in the circular).
  • The invocation must follow the contractual sequence.

What’s not allowed

Section titled “What’s not allowed”
  • Synthetic risk transfer dressed as DLG — for example, the LSP providing a “guarantee” of 30% of the portfolio that the RE counts as full credit-risk substitute. The 5% cap and the asset-backed-instrument rule together prevent this.
  • Implicit guarantees / “make-good” arrangements outside the formal DLG agreement.
  • DLG that effectively reverses credit risk to the LSP for the entire portfolio. The regulator looks at substance.

Applicability

Section titled “Applicability”

The DLG framework applies to digital lending arrangements between REs and LSPs. Co-lending arrangements between two REs (CLM-1 / CLM-2) are governed by the co-lending guidelines, not this framework — they may have their own loss-sharing structure but not under this framework.

Product implications

Section titled “Product implications”
  • LSP-provided DLG: the LSP must have the capital to fund a 5% cash / FD / BG against the portfolio it underwrites. For a ₹100 Cr portfolio, that’s ₹5 Cr of locked liquidity.
  • Pricing impact: the DLG cost is a real cost. LSPs that provide DLG must factor it into their fee economics; REs that receive DLG pay slightly more (in the form of LSP fees) for the protection.
  • DLG visibility to borrower: the borrower is not told about DLG. It’s a back-end arrangement between LSP and RE.

System implications

Section titled “System implications”
  • DLG agreement master — capture each DLG agreement: counterparty LSP, portfolio definition, DLG amount, form (cash / FD / BG), reference number, validity, invocation rules.
  • Portfolio tagging — every loan tagged to the DLG agreement it falls under.
  • DLG cap monitoring — real-time: DLG amount / portfolio outstanding <= 5%. Alert if ratio drifts (e.g., portfolio shrinks faster than DLG is reduced).
  • NPA-trigger workflow — when a loan turns NPA, mark for DLG invocation pipeline.
  • Invocation file generation — periodic file to LSP showing NPAs eligible for DLG invocation, amount, evidence.
  • Recovery from DLG — debit FD / BG / cash, credit borrower account (for accounting), record in invocation log.
  • Public disclosure report — total DLG, by LSP, by portfolio, annually.

Documents that must be generated

Section titled “Documents that must be generated”
  • DLG agreement.
  • Quarterly DLG cap evidence (system snapshot).
  • Annual DLG disclosure for board and public.
  • Invocation evidence for each NPA loan recovered against DLG.

Workflow that must exist

Section titled “Workflow that must exist”
  • DLG onboarding — LSP enters into written DLG agreement; deposits cash / FD / BG; instrument verified and recorded.
  • DLG monitoring — cap and instrument validity tracked continuously.
  • DLG invocation — NPA → eligibility → invocation → settlement → ledger update.
  • DLG termination — at end of LSP relationship or DLG cycle, instrument returned per agreement.

Reports that must be produced

Section titled “Reports that must be produced”
  • Internal monthly DLG cap report.
  • Annual DLG disclosure in financial statements.
  • DLG invocation log for inspection.

Audit evidence required

Section titled “Audit evidence required”
  • Original DLG agreement.
  • Cash / FD / BG instrument copies.
  • DLG cap computations over time.
  • Invocation evidence.
  • Public disclosure copies.

Operational design recommendations

Section titled “Operational design recommendations”
  1. Cap the DLG well below 5% in agreements. RBI scrutinises arrangements that sit at the cap — they look at substance and may re-characterise. Many REs prefer 2.5% – 3.5% DLG to leave headroom for portfolio shrinkage.
  2. Choose FD with lien marking over cash deposit — FD earns the LSP some interest, reducing the cost of DLG.
  3. Define portfolio precisely in the agreement — cohort? vintage? product? Without precise definition, the cap denominator is ambiguous and invites dispute.
  4. Automate the invocation pipeline — manual invocation is error-prone and audit-risky.

Sources

Section titled “Sources”
  • RBI Guidelines on Default Loss Guarantee in Digital Lending, DOR.CRE.REC.21/21.07.001/2023-24, 8 June 2023.
  • RBI FAQs on Digital Lending and DLG, available at rbi.org.in.